Understanding Employee Loans and Their Tax Implications

An employer can compensate an employee in various ways, including salary, company shares, or loans to assist with significant purchases such as a home or car.

Employee Compensation

Employers may offer loans to assist employees with specific purchases. These loans can be used to buy company shares, help finance the purchase of a principal residence, or fund personal needs such as home improvements or the purchase of a cottage. The loans may be interest-free, low-interest, or at current market rates, with various repayment terms.

Purpose of Employee Loans

Companies often provide employee loans to encourage the purchase of company shares, particularly for executives or management. This creates an ownership stake, aligning employees' interests with the company’s success.

Interest-free or low-interest loans may also be offered as part of a relocation package, helping employees cover moving costs.

Low-Interest or Interest-Free Loans

If you receive a low-interest or interest-free loan as an employee or shareholder, the CRA may deem it a taxable interest benefit. This benefit is calculated as the difference between the CRA’s prescribed interest rate and the actual interest rate charged on the loan, multiplied by the loan’s outstanding balance (calculated daily). Even though this benefit is taxable, the tax amount will be significantly less than the interest on a regular commercial loan.

If you are a shareholder and have already included the loan amount in your income, you do not need to include the interest benefit in your income.

Tax Treatment of Employee Loans

The tax treatment of employee loans is governed by several rules in the Income Tax Act to prevent tax-free or tax-deferred compensation. The way the loan is taxed depends on the relationship between the employee and the company, as well as the purpose of the loan.

For Shareholders

If you are a shareholder (or related to one) and receive a loan from the company, the loan is generally treated as income in the year it was borrowed. However, if the loan is repaid within one year after the end of the company’s fiscal year following the year the loan was made, it does not need to be reported as income, provided the repayment is not part of a series of loans and repayments. If the loan is repaid in a subsequent year, it qualifies as a deduction from income in the year it is repaid.

For Employees

If you are an employee and the loan meets certain criteria, it may not need to be included in your income for the year it was made. Even if you are both an employee and a shareholder, you may still qualify for this exemption if the loan was provided in your capacity as an employee and not as a shareholder.

The benefit will generally be deemed to have been received in your capacity as a shareholder if you have significant influence over the company’s business policies. However, this presumption may not apply if similar loans are offered to other non-shareholder employees.

To qualify for an exemption, the loan must be structured with bona fide arrangements to repay it within a reasonable time. Additionally, the loan must be used for one of the following purposes by an employee:

Who owns less than 10% of any class of shares in the company or who deals at arm's length with the company;

To purchase a home;

To purchase treasury shares of the company;

To acquire a car for use in carrying out their employment duties.

Taxable benefits are reported on the T4 slip in Box 14 or on the T4A slip in Box 117.

Loan Forgiveness

If an employer forgives a loan, the outstanding balance at the time of forgiveness will be included in your income as employment income. However, if the loan was already included in your income when it was received as a shareholder, you do not need to report it again.

Tax Implications of Forgiven Loans

The tax treatment of a loan from your employer depends on your relationship with the company and the purpose of the loan.

For the Company

Interest received from an employee is considered investment income to the company unless the company is in the business of lending money. This investment income is taxable.

Additionally, loans provided to employees or shareholders are not deductible to the corporation. If a loan to a shareholder is forgiven, the corporation cannot deduct the forgiven amount, leading to double taxation—where the forgiven amount is taxable to the borrower but not deductible by the company. However, if a loan to an employee is forgiven, the company may deduct the forgiven amount in certain circumstances.

For more information visit the Canada Revenue Agency: Canada Revenue Agency